1. IFRS and Basel 2 Ian Michael Accounting and Auditing Policy Department
Financial Services Authority
Contact:

2. IFRS and Basel 2: Key themes
Widespread adoption of IFRS
Interaction of IFRS with existing regulatory rules
Interaction of IFRS with Basel 2
Disclosure requirements

3. Widespread adoption of IFRS
IFRS increasingly becoming global standards
Adoption in EU from 2005 (mandatory for group accounts of listed companies)
Now used in nearly 100 countries

4. EU Experience
Adoption of IFRS appears to have gone quite smoothly, even though differences from national GAAPs often significant

5. Typical differences between IFRS and national GAAPs relevant to financial sector
Valuation – especially use of fair values
Classification of financial instruments
Hedge accounting
Consolidation
Netting

6. Interaction of IFRS with existing regulatory rules
Definition of regulatory capital
‘Prudential filters’

7. Definition of regulatory capital
IFRS (IAS 32) will sometimes indicate a different split between equity and liabilities than national GAAP
However, definition of regulatory capital driven to a considerable extent by the Basel Accord
Note that regulatory capital includes some elements which are unquestionably accounting liabilities, eg subordinated debt
However, impact of IFRS on measured equity is the key reason for prudential filters

8. Prudential filters (1)
Cash flow hedges. Under IAS 39, cumulative fair value gains/losses on hedging instruments are recognised directly in equity, to the extent hedges are effective
But such gains/losses excluded from regulatory capital
Application of fair value option to an institution’s liabilities. Gains/losses arising from changes in an institution’s own credit risk are excluded from regulatory capital

9. Prudential filters (2) Available – for – sale instruments loans
debt securities
equities
Own – use and investment properties

10. Two important areas of difference between prudential and accounting treatments
Securitisations
Netting

11. The Fair Value Option (FVO)
No prudential filter, but…
Supervisory Guidance on use of FVO by banks
Guidelines and recommended practices address:
Sound risk management and control processes for banks that utilise the FVO;
Supervisory consideration of banks’ use of the FVO in the context of evaluating the adequacy of risk management and regulatory capital
Approach to FVO needs to be set in context of a supervisor’s overall strategy towards an institution

12. Interaction of IFRS with Basel 2
Most significant issue is the relationship between accounting loan loss provisions, which under IAS 39 are based on an incurred loss model, and the Basel 2 concept of expected loss
This is discussed in draft Basel paper on ‘Sound credit risk assessment and valuation for loans’
Commonality of methodologies and data for credit risk assessment, accounting and capital adequacy purposes
Nonetheless, accounting and Basel 2 numbers may differ

13. Disclosure requirements
Enhanced transparency and its contribution to market discipline has been a major theme in prudential regulation, and accounting, in recent years
Prudential response: Pillar 3 of Basel 2
Accounting response: IFRS 7 – Financial Instruments Disclosures

14. Relationship between Pillar 3 and IFRS 7
May have different scope
Audit assurance probably higher for IFRS disclosures
Pillar 3 emphasises credit risk model embedded within Basel 2, and in some other respects is more prescriptive
So Pillar 3 and IFRS are complementary